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May 17, 2013

Stocks Have Room to Rise, but So Do Interest Rates: J.P. Morgan’s Kelly

It doesn’t take a crystal ball to see that ‘the biggest buyer of the worst assets in the world is the Federal Reserve,’ says Kelly

Sorry, investment strategists. Nobody, not even the smartest guy in the room, can look into a crystal ball and predict the capital markets’ future. The best way to understand what might happen tomorrow is to study the relevant data today, says David Kelly, chief global strategist for J.P. Morgan Funds.

Based on the available information that he’s seeing right now, Kelly believes that stocks have room to rise—but so do interest rates, he said Thursday in New York at J.P. Morgan Asset Management’s annual research summit.

With that, Kelly launched into an economic outlook that pinpoints the Federal Reserve as the biggest drag on the U.S. economy. Chances are the economy could have healed itself after 2009 and the markets would have returned to normal without massive intervention, he said.

“The biggest buyer of the worst assets in the world is the Federal Reserve,” he said, adding that the easy monetary policy of quantitative easing has gone past ineffectiveness to being counterproductive. The economy is recovering without stimulus and bankers are being discouraged from lending, which undermines business and consumer confidence, Kelly said.

Overall, the federal deficit is coming down a lot, but the real credit for the U.S. economy’s growth goes to consumer finances, with a rise in household net worth to $69.2 trillion in the first quarter from $67.4 trillion in the third quarter of 2007 along with a decline in household debt service, Kelly noted.

“There’s a battle between wealth and Washington, and wealth is winning,” Kelly said.

His recommendation for investors is to position their portfolios to prepare for a rise in interest rates: “We don’t know the day or hour, but we know this is going to happen.”

Kelly suggested that investment strategists quietly head for the exits, as if they’re leaving a dark and overcrowded theater. “Make no mistake, this inflationary environment is what’s most out of whack.”

Kelly also pointed to four big trends that he sees now in the data:

Even at new all-time highs, the stock market has room to rise. (JPAM is overweight equities, though Kelly doesn’t expect to see much in the way of double-digit returns going forward.)

Long-term investors should position portfolios for rising rates.

Developed-market economics are troubled, but developing-market stocks are cheap. Emerging-market stocks should benefit from stronger growth and sounder finances.

The post-recovery environment should favor more balance and active management.

The data indicate a difficult second-quarter 2013, and the bad news is that the expansion has been so “lousy” that many investors have missed out on it, Kelly said. “But the good news is that the economy will tick up in the second half of the year” as part of a long expansion, he said, adding that there’s plenty of room for more U.S. growth because “it’s hard to hurt yourself if you’re jumping out of a basement window.”

The popularity of the JPAM Guide to the Markets has now extended beyond the United States to include guides on Asia, Europe and Brazil. More than 140,000 printed copies of the guide are distributed around the world each quarter.